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Junk Rout Conundrum

If no one understands it, should you buy or sell?

There’s no obvious explanation for the 1.5 percent decline in U.S. high-yield securities in the past month, or the $9.9 billion of cash pulled from mutual funds that buy the debt. The most likely reason is that investors are increasingly uncomfortable hanging onto bonds that are expensive by historical measures.

Chalk this one up to a collective bout of angst that looks quite different from the 3.2 percent drop in speculative-grade bonds in May and June of last year. That rout was triggered by the prospect of less Federal Reserve stimulus and, while a withdrawal of easy-money policies still weighs on investors’ minds, that’s not the full story now.

“When Mr. Bernanke mentioned the word 'taper' last year, the world went crazy,” said Mark Lindbloom, a money manager at Western Asset Management Co. in Pasadena, California, referring to former Fed Chairman Ben S. Bernanke. “This is a different animal.”

Some evidence that high-yield bonds aren’t falling because of rising-rate concerns can be found in investment-grade debt. Investors plowed $10.4 billion into funds focused on those securities, which are more sensitive to moves in benchmark yields, according to an Aug. 4 Wells Fargo & Co. report.

Market Fuss

The question remains what to do about the selloff in junk. Every time the bonds have lost value since the end of 2008, they’ve rebounded right back and then some, delivering investors annualized returns of 17.3 percent in the period, according to Bank of America Merrill Lynch index data.

Lindbloom says he’s snapping up the debt. Jefferies LLC’s David Zervos wrote in a note to investors this morning, “Maybe I have been looking at different data releases than the rest of the market, but I don’t see what all the fuss is about.”

On the other hand, Morgan Stanley strategists said in a report today that “investors shouldn’t feel pressured to buy aggressively.”

Regardless of who’s right, the world’s biggest economy is showing signs of accelerating, which ostensibly would help the most-indebted companies. The U.S. will expand at a 3 percent rate next year, faster than the 1.7 percent growth in 2014, according to the median forecast of analysts surveyed by Bloomberg.

And even though the Fed is planning an exit strategy, U.S. central bankers keep saying they’ll maintain low interest rates for a long time.

So the souring of sentiment doesn’t seem to have its roots in economic weakness or monetary-policy concerns. More likely, Fed Chair Janet Yellen’s comments that she’s seeing some excessive risk-taking in high yield has worried investors who are also rattled by the fighting in Gaza and Ukraine.

Yields on junk bonds are still close to the lowest ever, and some investors are getting out while they can relatively easily—before everyone exiting at once tests a market where Wall Street is using less capital to facilitate trading.

The 6.2 percent yield on junk bonds is 2.7 percentage points below their decade-long average but 3.2 percentage points more than investment-grade securities, about the most since October, according to Bank of America Merrill Lynch index data.

It’s nerves that are driving things now.

Some say buy. Some say sell.

Western Asset is in the buy camp, betting this rout will be like all the others in recent years: short-lived.

“This type of behavior leads to some great opportunities for us and our investors,” Lindbloom said.

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